Today, we’re talking about how to Utilize The “House Hacking” Method For Commercial
Real Estate.
And if you’re new to this channel, I always leave a comment below with a table of contents
if you’d like to skip around. ________________
While the method has been around for quite some time, house hacking rose to popularity
as a real estate investing tool during the 2008 downturn.
Investors, looking to take advantage of better financing and better cash flow, started seeking
duplexes, triplexes, and quadplexes to purchase as owner-occupied investments.
They would live in one unit and rent out to one or more tenants that would help cover
the costs of owning the property. However, the house hacking method isn’t
just for residential property. Commercial real estate investors can utilize
this strategy to start building their portfolio of investments while their tenants cover the
costs. Here’s how:
First, What Is House Hacking?
House hacking is a real estate investment strategy that involves renting out portions
of your primary residence in order to generate income to offset the costs, such as your mortgage
and operating expenses, of owning the property. When executed correctly, not only will it
allow you to live in your property for free, you may also generate positive cash flow from
your investment. Not bad, right?
This investment strategy allows you to squeeze every bit of value possible out of your property,
which will benefit you financially. However, just like many other real estate
investing strategies, house hacking has its downsides, too. If you’ve found an outstanding
deal on the price, the project may require a little more work on your part as the investor.
Being one of the tenants in your own investment property can also be uncomfortable for some
landlords. Those temporary discomforts are worth the
benefits, though, which we’ll dive into here shortly.
Now, here’s how you can apply This Method To Commercial Real Estate
For most small business owners, your rent will be one of the largest liabilities on
your balance sheet. And if your lease is NNN, not only will you
be covering the landlord’s mortgage payments, you’ll also be paying to maintain the common
area and covering the property taxes & building insurance.
You might as well own the property - you’re essentially paying all the expenses already,
anyway! Yes, you will have to come out of pocket for
a down payment on the property, but you will be building equity into a commercial real
estate investment for yourself. So, find yourself a building and some tenants.
Also - it’s worth noting that you don’t have to own a business for this method to
work. I’ve had clients use this same strategy with hotels and multifamily properties where
they live on-site and operate the investment. You can utilize the “house hacking” strategy
with almost any kind of commercial real estate: * Multifamily
* Office * Retail
* Industrial * Hospitality
* And so much more - depending on how creative you get
And if you’d like to learn more about the different types of commercial real estate,
check out this video here. When you purchase a building using this method,
I highly recommend that you treat yourself and your business as two different entities.
Most of our investors, including myself, will purchase the property in one entity and lease
the space back to their business. Doing so will relieve the liability on the business
and will give you tax benefits, which we’ll discuss later. Of course, you’ll want to
consult your CPA first. By “house hacking” a commercial property,
you will be able to free up cash flow for saving, investing, or paying off your mortgage
that much faster. Here are a few different ways you’ll free
up your cash flow: * - Lower monthly rent payments since tenants
will be bearing the majority of expenses * - Lower taxable income since you’ll have
more tax write offs * - Positive cash flow from tenants’ rent,
which you can reinvest into more property And if you ever outgrow the space, it’ll
always be there to provide you with rental income, too. Then, you can move on to the
next building and repeat the process!
Now, let’s discuss Why you should “House Hack” Commercial Real Estate
We’ve already covered how “house hacking” commercial real estate can significantly lower
your costs. I touched on how you can start growing your
investment portfolio, as well. But there are many benefits to “house hacking”
commercial real estate. Here are just a few:
Better Financing Terms
If you choose to take the owner-occupied financing route, you’ll find better terms from your
lender. To qualify for owner-occupied financing on
commercial properties, most banks will require you to occupy at least 51% of the space. I’ve
seen some lenders accept as low as 30%, depending on the client’s relationship.
With owner-occupied terms, you’ll typically be able to benefit from a lower down payment
( in the 10% to 15% range), have a lower interest rate, and longer amortization terms.
Banks are often willing to offer better financing terms for owner-occupied commercial real estate
since it’s seen as less risky.
Cash Flow Potential for cash flow from the investment
is one of your primary benefits of “house hacking” commercial properties.
Not only will your tenants cover the expenses involved in owning and operating the property,
you may be able to benefit from extra capital after everything is paid.
You can use this cash flow to offset your business’ cost of renting the space, take
that capital and reinvest it into other properties, or utilize it to pay down your loan faster.
Landlording Experience Lenders like experience.
And if you’re looking to grow a portfolio of commercial real estate investments, you’ll
probably be working closely with lenders so that you can utilize leverage to purchase
more properties. The investor’s experience is an important
part of a lender’s risk profile when determining whether or not lending you money makes sense
for them and their bank. No better way to gain investment property
experience than on a project that you occupy! You’ll be intimately involved in the day
to day and will learn the ins and outs of leasing to potential tenants, managing the
property, dealing with contractors, and producing financials.
Not only will this experience make your investments more successful, but it will also allow you
to take down larger projects with the lender’s support.
Tax Benefits
Commercial real estate comes with many tax benefits.
Not only will your business be able to write off its rent payments, as the landlord, you
will also be able to write off interest payments, any expenses related to maintaining or upgrading
the property and structure, as well as depreciate the asset.
Of course, you’ll want to speak with your CPA before moving forward on any of these
write-offs. And if you decide to sell the property? You
will be able to execute a 1031 exchange to defer any capital gains tax on the investment
and place that capital into another project.
Passive Income
Your money works for you! If done correctly, owning commercial real
estate can generate passive income. Whether you go to work tomorrow or take a
vacation, those rent payments will keep coming through the door. Mailbox money.
Passive income is how you build true wealth through real estate, and you can use this
“house hacking” strategy on commercial real estate to begin building up that portfolio
so that you don’t have to work if you don’t want to.
Commercial real estate can be amazing for your retirement plan.
Which do you like better - the passive income or the tax benefits? Let me know in the comments
below.
Let’s cover The Math Behind Commercial “House Hacking”
So, we’ve covered how this strategy can lower your expenses and help you build up
your investment portfolio. Let’s dive into an example of how your commercial
“house hack” might work. * Let’s say you have an 8,000 sq. ft. commercial
space with a $1,200,000 purchase price * * market rents are $20.00 per sq. ft. NNN
with $3.00 per sq. ft. annual operating expenses Your lender has offered terms with 15% down,
4.5% interest, and a 25-yr amortization. * To make things simple, let’s say you decide
to owner-occupy 51% of the building so that you qualify for a 15% down payment. Your out
of pocket expense for this project will be $180,000.
Your business will occupy 4,080 sq. ft. while you list 3,920 sq. ft. for rent at market
rates of $20.00 per sq. ft. NNN. As I mentioned earlier, you will want your
business to pay market rents because of the tax implications, so your gross revenues will
be: * $160,000 per year in Base Rent ($20.00 per
sq. ft. x 8,000 sq. ft.) * $24,000 per year in Additional Rent (these
are your NNN pass-throughs) * Which gives you an annual total of $184,000
So now that you have your estimated gross revenue, let’s look at your expenses:
* You will spend $24,000 per year on Operating Expenses (which is covered by your additional
rent) * $4,080 on Utilities (estimated at $1.00
per sq. ft. annually) * And $68,028 on Mortgage Payments
* That brings us to $95,948 in Total expenses Now, this is a very simplified version of
investment underwriting. However, these numbers are close enough for
the purposes of this example. In this scenario, you’ve profited $88,052
on a property that you’ve commercially “house hacked.” With down, that’s a 49% cash
on cash return. Not bad! However, some investors decide not to have
their business pay them rent and instead opt to have the business just cover the remaining
expenses on the property after they’ve collected rent from the tenants.
If that’s the case, the tenant will pay gross rents of $90,160 ($20.00 per sq. ft.
plus $3.00 per sq. ft. in pass-through NNN expenses).
Your business would be responsible for paying the difference of $5,788 on 4,080 sq. ft.,
which brings your effective rent to $1.42 per sq. ft.
When you put numbers to paper, it’s pretty easy to see how “house hacking” commercial
property not only makes sense for you as an investor, but also for your business.
Here are your Financing Options For Commercial “House Hacking”
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When “house hacking” commercial real estate, you’ll have a number of different finance
options.
First, Conventional Loans Conventional commercial real estate loans
are best if you have cash to cover the down payment of around 20%. This type of loan will
often have some of the lowest fees and fairly competitive rates.
However, conventional loans are one of your less flexible loan options, usually require
a minimum of 20% down payment, and have shorter loan terms and fixed rate periods (often in
the 5 to 7-year range).
SBA Loans The SBA loans offer buyers a better option
than conventional loans with respect to longer fixed rates and term lengths. This product
will often be more flexible with lower rates than conventional loans.
SBA loans often have higher fees, lower down payment requirements (usually 10%), and stricter
prepayment penalties than your other options. While they can be exhausting to qualify for
since you have to jump through the SBA hoops, they do allow you to come out of pocket less
on the front end. Hard Money / Private Money Loans:
If you’re working on a tight timeline or don’t qualify for the other options above,
a hard money or private money loan could be a strong option for you.
These loans are sourced from the private market, meaning a lender other than a financial institution.
These loans are typically short-term with higher interest rates and the approvals are
based more off the property or project rather than the borrower.
Hard money / private money loans are often referred to as “bridge loans” because
investors will typically utilize them for the interim while negotiating a longer term
conventional loan.
Let’s cover Common Objections And Challenges With Commercial “House Hacking”
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When I pitch this investment strategy to clients, there are almost always a few objections.
In fact, I had some objections to it myself, before I ended up doing it with The Cauble
Group’s office in East Nashville. Here are a few of the common objections and
challenges (and my responses) that you may face when you’re “house hacking” commercial
real estate:
I Don’t Want To Rent Space Next To My Tenants This objection is pretty reasonable.
Most individuals are not comfortable having personal and business relationships mix, which
is often the case if you’re onsite with your tenants.
One upside here, though, is that you get to choose your tenants. Not only can you financially
vet them to make sure they will have the means to pay rent each month, but you can also check
character references to ensure that prospect is a tenant you’d like at your property.
Now, some may also see a tenant’s ability to just knock on your door with maintenance
issues or rent concerns, but I see that actually being a positive. If you break down the barriers
for tenants to report any issues with the buildings, they might not just “ignore”
them. You may find you actually enjoy getting to
know your neighbors, too, and that it won’t be an awkward situation.
Won’t I Be Responsible For Maintaining My Property?
Well, yes and no. Yes, it will ultimately fall on you to maintain
the quality of the property, which means any issues that arise in your tenants’ spaces
(depending on how your lease is structured) will become your responsibility.
Now, you could spend the time building up a solid vendor list of plumbers, electricians,
handymen, etc., which is a good route to take if you eventually want to quit your day job
and run property full time. However, if you intend to continue focusing
on your business, hire a property management company.
The property management company will not only keep you at arm’s length from your tenants
when it comes to rent, they’ll take the overwhelming majority of the day to day decision-making
off your hands. And as I’ve said before - if the deal doesn’t
make sense when you add in management expenses, it probably doesn’t make sense anyway.
I Can’t Find A Good Deal
Finding investment deals that work for you can be challenging. Especially in commercial
real estate. In fact, it’s not uncommon to look at 100
different properties just to find one that would not only fit your investment criteria,
but would also make a suitable home for your business.
Put your broker to work. Get out there and hit the streets yourself. There are many different
ways for you to go about finding a deal that suits your needs.
And in truth? Every real estate market is different. If you live in California, you
may not be able to produce cash flow from your investment property, but chances are
good you can still reduce your cost of living (or business operating, rather).
Get out there and turn over those stones. You’ll find the gem eventually.
And it will be worth it.
﻿What If I Have Any Issues With The Tenants?
Even if you vet your tenants correctly, there’s always a chance something could go wrong.
They lose a major customer. Their business model changes. They can’t pay rent.
These issues are why I appreciate having a property manager between me and the tenants
at my properties. They will handle all of these issues without my involvement.
Of course, it usually makes sense to work with a tenant to figure out how you can get
through any situation together, but that isn’t always the case. If you have to enforce some
aspect of your lease or, worse, evict the tenant, the property manager will take care
of everything. Take advantage of those services and let them
work on your property while you work on your business.
One Final Thought… ________________
If feasible, you should occupy the least desirable space.
When “house hacking” commercial real estate, those least desirable spaces on the property
will be among the most difficult to rent to potential tenants.
So, by occupying the least desirable space, you will make it much easier on yourself and
your cash flow in the long run. Now you know how to house hack commercial
real estate.
If you liked this video, please give it a thumbs up. If you have any questions, feel
free to leave me a comment below and I’ll be sure to get back with you. And if you’re
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